China’s stimulus package holds promise

CHINA’S policymakers have implemented their most vigorous stimulus initiative in years, commencing with a series of monetary measures on Sep 24 that include interest rate reductions, reserve requirement adjustments, property market easing and capital market support.

Just two days later, top officials followed up with direct pledges to stabilise the property sector and ramp up fiscal spending in a surprise September Politburo meeting focused on the economy and chaired by President Xi Jinping.

At the meeting, China’s top leaders explicitly pledged to “stop the property market from falling”. This is the first time that a high-level meeting like this has so directly and specifically mentioned such a target.

The measures that have generated the most enthusiasm among investors are an unprecedented 500 billion yuan (S$92.4 billion) swap facility – allowing institutions to borrow funds for stock purchases – announced by the People’s Bank of China (PBOC), and an additional 300 billion yuan facility enabling companies to take loans for share buybacks.

While the details of the scheme have not even been published yet, the announcement’s effect has been powerful, triggering an intense and rapid rally across Chinese assets.

The MSCI China is up 35 per cent over the past month, the CSI 300 (up 26 per cent) and Hang Seng (up 40 per cent) indices have both posted their best weeks in decades, and the Chinese yuan has broken below the psychologically important 7.0 against the US dollar.

The rapid turnaround in sentiment reflects a growing belief that the long-awaited policy game changer has finally arrived.

We have cause for optimism based on key lessons learnt from the measures implemented thus far, but the full scope, scale and implementation of the stimulus are still unknown.

To stabilise the real estate market and boost consumption, a fundamental turnaround will probably need more support from the growth perspective, especially on the fiscal front.

Fiscal factor

China’s policymakers may need to increase their reliance on fiscal policy to ensure that funds are directed to their intended destinations, and to be more effective in the event of a liquidity trap – a scenario in which additional easing is unable to significantly increase aggregate demand.

We see a rising chance for a large-scale fiscal stimulus package of five to 10 trillion yuan or more in the coming years, to support long-term demand.

This shift in sentiment would assist China’s economy in escaping the liquidity trap it is currently in, thereby enhancing the efficacy of monetary policy and potentially initiating a virtuous circle of policy support.

Affordable housing and social welfare network improvements (such as in healthcare, education and care for the elderly) are likely recipients of the monies.

The next key policy events to watch include the National People’s Congress Standing Committee and Politburo meetings, both in October. Sufficiently large stimulus could allow gross domestic product growth targets to remain anchored around a reasonably healthy 5-per-cent level in the coming years.

Supplementing this could involve financing these fiscal support measures through the central government, potentially with the PBOC acquiring treasuries to enhance liquidity in the Chinese government bond (CGB) market.

There could be more bull-steepening of the CGB curve in the months ahead. As a result, we revise our 10-year CGB yield forecasts to 2 per cent for December 2024, and 1.9 per cent from March 2025.

Beyond animal spirits

Setting animal spirits alive in the stock markets is the easy part. Beyond that, stock market trajectory will depend on more clarity around fiscal support, policy execution and capital market buying – all of which have come close to or exceeded expectations, given the better policy coordination and strength to date.

The main challenge from hereon is to resolve the local government debt and property issues decisively so that they will not lead to an economic and psychological malaise, like what Japan experienced.

Debt restructuring (deflationary) and credit creation (stimulative and inflationary) must be balanced to reduce debt service burdens while avoiding unacceptable deflation or inflation.

However, local government debts are particularly challenging to manage, because they are typically incurred by local governments that fund their expenditures through the sale of land and loans from local businesses and citizens.

But, China has history on its side. Similar problems have been faced and dealt with throughout history, including during the 1990s in China with the Jiang Zemin and Zhu Rongji leadership, in ways that were both effective and painful. This time round, it will still be difficult and painful, but not insurmountable.

Slow, painstaking, often fitful improvement is probably the only way this festering ghost ship of a Chinese property market and local government debt is ever going to right itself.

The writer is chief investment officer for South Asia-Pacific, UBS Global Wealth Management